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12 October 2016

On the Debt of Nations



Where did it all start? Where does it all end?

As the European economies flag, with southern Europe drowning in debt and threatening the existence of the EU, Monty Python might ask: “What have the Italians ever done for us?” Well actually quite a lot. They invented the banking system in Europe, and they also introduced municipal debt, which morphed into the national debt and the US treasury bill in modern times. The introduction of public sector debt by the Italians was a breakthrough that gave savers somewhere safe and available to put their money, rather than having, say, to wait for repayment from the proceeds of the next harvest with its uncertainties. This public debt model of safe, liquid instruments was replicated in the private sector to become the foundation of the financial markets we know and love today.

So there we have it. The Italians gave us savings instruments, whether bank deposits or municipal bonds, so that debt could fuel the economy. Where there are debtors, there are savers, so that in simple terms the one matches the other, a bit like the principle young economists learn that says in any economy savings equals investment. Can we have too much debt? The question that is probably better asked is about who has the debt and who has the savings. The statement that people today have too much debt could be rephrased to the statement that people today have too many savings. It is just that they are not the same people.

Max Weber (1854 -1920) was a German thinker who did not share the views of his contemporary, Karl Marx, but gave us The Protestant Ethic and the Spirit of Capitalism. It makes great reading. The gist is that the ethics of the god-fearing protestants of northern Europe obliged them to work hard but not to enjoy themselves by spending their earnings, unlike the southern Catholics who would work as much (little) as necessary before lunch and a nap in the afternoon. This resulted in the wealth accumulation that underlies capitalism. It also suggests that savers and debtors may not be the same communities.

Where we have markets, take commodities as an example, there are buyers and sellers, and there is a mechanism for matching supply to demand, which is called price. This leads to all sorts of things to do with competitive advantage, giving rise to international trade flows and all the benefits and imbalances that go with them, whether of physical or regulatory derivation. If we look at savers and borrowers, the obvious balancing mechanism to compare to ‘price’ is ‘interest rate’, but there is much more to it than that. The problem of the accumulation of savings has been dealt with in many ways in many different places under many different guises, with varying degrees of moral integrity, but which all achieve a similar objective of reassignment of wealth. There are many labels, so let’s list a few: theft, expropriation, progressive taxation, inflation, hyperinflation, coin clipping, money printing and, of course, quantitative easing (or did I already mention that?). These solutions have been variously applied in South East Asia, South America ....

Whereas taxation and inflation are common tools that work within an economy to solve the savings accumulation problem, the international trade flow problem is more awkward. The modern economic system has tried to use price and foreign exchange mechanisms to maintain balance. Lower wage workers in emerging/developing economies supply goods at low prices to wealthier economies, so not too much money flows to them to create an imbalance that cannot be handled by currency adjustments. However, there is a pattern of development, be it Japan in the 1960s, the Asian Tigers in the 1980s or China today that undermines this harmonious co-existence. Eventually, imbalances develop. The Chinese workers today may still not be high earners but the volume of output with improved quality and price has become so huge as to create a massive trade imbalance that is equivalent to a savings imbalance. Max Weber’s spirit of capitalism is alive and well. Accumulated savings flow into the safe haven of US treasury bills, impacting the US dollar’s value, affecting at the same time its acquisitive power to keep importing and the debt status of the US nation. This is a monetary and trade imbalance that is a difficult one to deal with. Contrast this with the oil price shock of the 1970s, when the recycling of petrodollars is said to have been successfully handled by the international financial system. This was a sudden shock and it was nothing like the scale of what is faced today. Conspiracy theorists may suggest that the US applied various solutions in the past, be they lend-lease, the Marshall plan, currency revaluations/devaluations or simply the practice of selling pieces of paper called greenbacks in multiples of dollar value at vastly above the price of the security paper, printing and ink for foreigners to keep in mattress or use for illicit trade – in Russia alone holdings of US dollar notes amount to many billions of dollars, which is therefore value the Russians have given the Americans for free. Some economists might agree partly with the conspirators, but there is not an apparent solution to the problem here.

So if it started in Italy, and we have now reached a situation of massive international imbalances of savers and debtors that are straining the international financial system, be it within Europe or between the US and China, where does it end?

Did we not choose Theresa May as our prime minister to give us answers? Perhaps we will hear from her once she has examined the evidence. In the meantime, it’s down to Clinton and Trump. 

God save bless America.


This article was written by Fred Piechoczek. All views and opinions are strictly his own.

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